Tether Tantrum and the Need for a 'Stablecoin’

Volatility has long been a problem nipping at the heels of cryptocurrency traders, but most have embraced daily, double-digit intraday percentage swings as the price of investing. Though the market’s ups have traditionally been as big as its downs, the problem isn’t about making or losing money, it’s that traders who want to escape this volatility didn't’ have the means to do so until Tether emerged in late 2015.

As experienced cryptocurrency market participants can attest, many coins rise and fall on the whims of bitcoin — the granddaddy currency that acts as a barometer for the entire industry. For members of an exchange with fiat money deposits and withdrawals, escaping bitcoin’s volatility was simply a matter of selling their coin for cash, but this rudimentary method requires complete divestment. It also doesn't’ consider the fact that cryptocurrency being sent between accounts is equally exposed.

Traders sending bitcoin, whether to another exchange’s wallet or to another person, must tolerate the decentralized network’s slow processing. In the hours that it often takes to receive a bitcoin payment, it might have lost (or gained) substantial value. Not only is this untenably risky for the average trader, it makes doing business with bitcoin extraordinarily challenging. What business owner wants to use a currency that will result in them overpaying, or underpaying their suppliers? It’s possible to send fiat money between exchanges as well, but the hurdles in place are tall, and exchanges don’t universally accept fiat transfers.

Tether entered this market with an intelligent solution: a cryptocurrency that has a static value equivalent to one U.S. dollar. There are also Tethers pegged to the euro’s value, but the concept remains the same: a way to gain shelter from the market’s volatility without exiting the ecosystem entirely.

Tether Troubles and Turmoil

For a time, Tether helped the cryptocurrency market immensely. With institutional banking partners and the promise that each Tether was backed by a proportionate amount of fiat, the new "stablecoin" fulfilled its promise to traders and helped all stakeholders operate with greater ease and efficiency. It opened arbitrage opportunities between exchanges listing Tether, made it easier to send and receive funds, and helped funnel capital into the young cryptocurrency market. (See also: Price Difference In Bitcoin Futures and Spot Markets Presents Arbitrage Opportunity.)

However, some suspicious events occurred that impacted Tether’s credibility. Tether is the only entity that can mint its namesake coin, and transparency is crucial for such a centralized concept.

The market’s confidence in Tether was shaken after they missed consecutive deadlines to release an audit of their operations, leading to their accounting firm severing all ties with the company. Additionally, savvy analysts discovered that large batches of Tether were printed consistently when bitcoin’s price dipped, keeping it inflated, possibly through fraud.

The biggest problem with Tether, as evidenced from these events, is its centralization. With only a single entity acting as the currency’s authority, Tether is opaque and unsuited to its role in the market. Should an audit prove that Tether acted fraudulently, it could spell doomsday for cryptocurrencies far and wide. Traders will instantly recognize that the value of the coins they hold has been artificially inflated, and rush for the exits.

Justifying a Stablecoin Economy

To be clear, the market at large supports the notion of a stablecoin. Until technology in the space improves, coins that derive their value from fiat currency are a solid solution, but they must be more transparent than Tether.

Many in the industry have tried to create alternatives, but one of the most purposeful comes courtesy of Kowala. The company recognized the inability of Tether to provide a transparent stablecoin and has built a solution that comprehensively addresses the weaknesses of its predecessor.

The crux of the platform is kUSD , a fiat-backed stablecoin whose underlying deposits and transfers are visible to the community via the decentralized ledger. Instead of being haphazardly printed based on demand that no one can confirm, kUSD is mined like a traditional cryptocurrency based on the public information from multiple exchanges gathered via a trust-less system of oracles.

"Fiat-backed cryptocurrencies are not actually cryptocurrencies,” said Eiland Glover, the CEO of Kowala Tech. “Because they are centralized. They require users to trust the party holding the fiat currency assets not to steal or lie and to protect those assets from theft and intervention from governments or banks. This centralization creates a single point of failure absent in true cryptocurrencies like bitcoin and Ether. In fact, over-dependence on fiat-backed tokens such as Tether currently poses a threat to the entire cryptocurrency market."

This existential crisis is why new, decentralized cryptocurrencies like kUSD are so desperately needed. Decentralized stablecoins promise to combat the threat of fiat-backed tokens by using algorithmic and market mechanisms, instead of a central authority, to autonomously stabilize their prices. Such an idea helps to encourage businesses and individuals who had previously been on the fence to finally adopt and benefit from cryptocurrency services, providing increased momentum to the industry as well.

Building the Foundation of a Crypto-Economy

Just as bitcoin was created out of a need for more transparent, independent payment processing and settlement services, Tether also had its origins in necessity. However, bitcoin has since been proven a relatively primitive answer to the finance industry’s problems, and Tether will meet the same fate.

This young market’s MVP solutions are likely to go through many iterations before they can find balance, but progress by innovators is thus far inspiring. All that remains is for exchanges to standardize those solutions with the best value proposition, and for enthusiasts to take those cues and throw their support behind them as well.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.

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